Treasury Secretary Lew testified today before the Senate Banking Committee on the Financial Stability Oversight Council (FSOC) Annual Report to Congress. His written testimony identified seven areas of risks to U.S. financial stability:

· First, market participants and regulatory agencies should take steps to reduce vulnerabilities in wholesale funding markets that can lead to destabilizing fire sales. · Second, significant reform in the housing finance system is still needed.· Third, government agencies, regulators, and businesses should take action to address operational risks from internal control and technology failures, natural disasters, and cyber-attacks, which can cause major disruptions to the financial system.· Fourth, as recent developments with the London Interbank Offered Rate (LIBOR) have demonstrated, reforms are needed to address the reliance on voluntary, self-regulated, and self-reported reference interest rates. · Fifth, financial institutions and market participants should be cognizant of interest rate risk, particularly given the historically low interest rate environment of the past few years. · Sixth, long-term fiscal imbalances that have potential economic and financial market impacts should be addressed.· Finally, regulators need to continue to keep a close eye on potential threats to U.S. financial stability from adverse developments in the global economy.

With respect to the first risk, Wholesale Funding Markets, the Secretary's written testimony focused on the need for additional reforms related to money market mutual funds:

The Council remains concerned that vulnerabilities in wholesale funding markets could lead to destabilizing fire sales. Specifically, run-risk vulnerabilities related to money market mutual funds (MMFs), which became apparent during the financial crisis, still remain, despite an initial set of reforms implemented in 2010. In November 2012, the Council issued proposed recommendations for public comment to implement structural reforms of MMFs to reduce the likelihood of runs. Council members should also examine whether similar reforms are warranted for other cash management vehicles.

The Secretary's testimony noted that:

The Council is also authorized to issue recommendations to a regulatory agency when financial activities and practices are creating risk for U.S. financial markets. In November 2012, the Council issued for public comment proposed recommendations to the SEC with three alternatives for reform to address the structural vulnerabilities of MMFs. The Council is currently considering the public comments on the proposed recommendations. If the SEC moves forward with meaningful structural reforms of MMFs before the Council completes its process, the Council expects that it would not issue a final recommendation to the SEC. However, if the SEC does not pursue additional reforms that are necessary to address MMFs’ structural vulnerabilities, the Council should use its authorities to take action in this area.